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While I see the risk of a lower low in Gold to come, I am
looking forward to a possible stock market crash in the U.S. soon and a
subsequent Fed reversal of policy to cause a peak in the dollar and a historic
bottom in Gold, other precious metals, and commodities in general.

Gold’s peg to the yuan remains intact. USD/CNY is the
principal driver of Gold prices and has been since USD/CNY bottomed and Gold
peaked on April 11, five months ago. China has been devaluing the yuan to
offset U.S. tariffs. The U.S. plans to implement 25% tariffs on 40% or $200bln
of Chinese exports to the U.S. on Sept 5, coupled with the risk that the U.S.
threatens to add 25% tariffs on the remaining $300bln also. If this were to
occur, I would expect USD/CNY to rise further, possibly greater than 7, causing
Gold to fall to lower lows.

News of trade talks between the U.S. and China this week
predictably led to a drop in USD/CNY as China tried to appease the U.S. prior
to the talks.

Gold finally caught a bounce as a result.

However, as each graph above shows, both had partially
reversed their recent moves prior to completion of the talks due to declining
expectations of a positive outcome. Negative comments from both sides ahead of
time regarding prospects for the meeting, coupled with the fact that lower
level officials from the U.S. and China were taking part, tempered hopes for
any kind of resolution.

Now the risk is that 25% tariffs are implemented on Sept 5,
the USD/CNY rises as expected and Gold falls to lower lows.

I would welcome such an outcome because it would enable
purchase of physical Gold at bargain prices, given what I expect to come in the
next few months. There is a perfect storm brewing for stocks, and a significant
increase in the USD/CNY would only compound those headwinds contributing to a
crash in the U.S. stock market of ~30%, in my opinion.

Given the importance of stocks to Federal Tax Receipts, I
expect the Fed to revert to “stimulus on steroids”. The latest FOMC minutes on
Wednesday confirm this expectation. The Fed opened the minutes talking about a
return to ZIRP, QE, and other alternative policy tools in response to the next
crisis. It also cited the trade war as the principal risk to the economy and
markets. Should such a crash occur and the Fed does reverse policy, I expect
the dollar to peak and fall. USD/CNY would likely peak and fall too. At this
point, Gold would begin a truly meteoric rally.

Why do I say meteoric? We just have to look at the
traditional indicators, such as technicals, sentiment, and positioning, for the
fuel for such a rally.

POSITIONING

Money Managers (“Funds”)—the so-called “dumb money”, because
they tend to be wrong at extremes—had the biggest net short position ever since
records began in 2006. At 83k contracts, that is more than three times greater than
the previous record set in December 2015, when Gold bottomed and began its
historic rally from 1045 to 1377 in just over six months.

This provides a massive amount of fuel for the rally in Gold
once it starts, and these Funds have to cover their record level of shorts.

At the same time, the Commercials—the so-called “smart money”,
because they tend to be right at extremes—had their lowest net short position
since December 2015. When you strip out the Producers component, the Banks are
actually long, ready and waiting for the coming rally. Of course, Funds could
become even more short and Banks even more long, but this is extremely bullish
for Gold once the bottom is reached and for the size of the rally to follow.

SENTIMENT

Gold made a quadruple bottom at a spot DSI of 6 last week,
which most would consider extremely bullish. But we were at a low of 10 back on
May 15
th, and we’ve been in and out of single digits since, yet Gold
continued to fall in price.

Furthermore, Gold may choose to repeat what it did in
Nov-Dec 2015, when it rose from a positively divergent higher low in the spot
DSI but at a lower low in price (shown by purple line below). This supports my
view for a higher low in the spot DSI but at a lower low in the price of Gold
to coincide with an end to the trade war or a reversal in Fed policy.

The 21-day moving average is a lagging indicator relative to
the spot DSI, but it is less volatile and therefore a better indicator of the
trend in sentiment. It fell to a low of 10.9 last Thursday, its lowest level
since December 2016, when it reached 9.7. Gold rose straight up from there in
2016, and it could do so again in the weeks and months ahead.

Alternatively, it could also repeat what happened between
August 2015 and January 2016 (shown by orange line above). The 21-DMA bottomed
at 12 in August 2015, rose, then fell back to a positively divergent 14 in
early January 2016. Like the spot DSI, this marries well with my expectation
for a lower low in Gold before it takes off on a Fed policy reversal.

Massive fuel here, too, for the rally to come, sentiment is
clearly uber-bearish.

TECHNICALS

Suffice to say that Gold has suffered some major technical damage.
The trend is clear: A series of lower high and lower lows. Other than being
horrendously oversold until the current bounce, there is little chart-wise to
be bullish about, in my opinion.

Gold has fallen over $200 from its peak in April, with
barely a bounce along the way. All thanks to the trade war and USD/CNY, in my
opinion. Gold hasn’t been able to reach its 23.6% retracement of the entire
decline from 1369 to 1168 at 1216. There are multiple Fibonacci resistances
between 1211-1223.

Focusing on the weekly chart for whatever bright
spots there are, the slope of the decline and its size is almost as bad as that
following Trump’s election in November 2016, which is counter-intuitively
bullish.

The RSI is extremely oversold at 24. The MACD Histogram does
appear to have bottomed and is slowly turning up. The MACD Line is over-extended
and close to December 2016 lows. Gold is setting up well for a positively
divergent lower low, if it chooses to do so. There is little in the way of
support between here and the 2016 low of 1124, save for the 1168 low last week.

CONCLUSION

Given the expected failure of the trade talks between the U.S.
and China, it is likely that additional 25% tariffs are implemented by the U.S.
on Sept 5. If this occurs, I see USD/CNY going higher and Gold going lower in
the short term. But Gold is just building up fuel from a technical, sentiment
and positioning perspective to soar higher once the USD/CNY peaks.

On that note, many are rightfully upset about the decline in
Gold and the contribution of China to that decline via the weakening of the
yuan. In my opinion, China controlling the Gold price is the best thing that
could ever have happened to Gold in the long-term. Unlike the Bullion Banks on
the COMEX, China has a vested interest in a higher Gold price long-term—once
they are done buying it on the cheap in dollar terms, that is. They want an end
to the dollar as the global reserve currency. What do you think will happen to
Gold in dollar terms when that occurs? This is the reason that China has been
loading up on Gold for years. Russia too. To hedge against a crash in the
dollar.

Follow the smart money long-term.

David Brady has managed money for over 25 years for major international banks and corporate multinationals both in Europe and the US, with experience in Bonds, Equities, Foreign Exchange, and Commodities

In 2016, he created GlobalProTraders.com, an interactive online community for traders to share their views on financial markets.

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